The housing recovery is still incomplete. Even in the nation’s fast-growing metro areas, new construction is not keeping pace with demand. The lack of supply has created a housing shortage and is well known at this point. What is less discussed are the reasons why we have under-built housing. Given high rents and home prices, why haven’t we seen a stronger supply response to chase those profits? Our office has dug into 5 of the most commonly cited reasons. Our summary is below. A major H/T and thank you to the National Association of Home Builders (NAHB) economic team for their work on many of these issues.
Supply Constraint #1: Confidence
Anecdotal reports and conversations suggest spec development is down. It is possible that builders and developers have lost some of their appetite for risk. If they wait to build until a contract is signed, or close to it, supply will continue to lag demand. However, as Mark said at City Club of Portland, a successful developer by their nature is optimistic. The NAHB Wells Fargo home builder sentiment index is all the way back to previous peaks. As such, it is unlikely that the lack of builder confidence is what is really holding back the market.
Supply Constraint #2: Labor
For years now, a common refrain has been that it is hard to find construction workers and that wages are really high. NAHB reports there is a shortage for a number of occupations. I remember hearing about these shortages back in 2013 and 2014, which, at the time, was a bit hard to believe. Not that it wasn’t true, just that there was clearly slack, and available workers, in the economy. Now? I certainly believe it is hard to find workers, for any industry. The labor market is tight. That said, average wages in the construction industry are well within their historical range, when compared with other Oregon workers. Again, this does not mean there are not labor issues in the construction industry, and there can certainly be skill-specific shortages. But in general, what the industry is experiencing is felt across a wide range of sectors.
Even so, we are hearing that labor costs and bids are really high today. So if it is not showing up in workers’ paychecks, that means it might be showing up as firm profits. Some of this increase could be due to market power and industry consolidation after the crash. Furthermore, we are reminded by our advisors, that even as firm profits are rising again, this is cyclical. These are the same companies that lost their shirts during the crash, and will likely do so again next cycle.
Supply Constraint #3: Land Use
In our office’s presentations around the state, the first reason or theory everyone cites is our state’s unique land use laws. Specifically the urban growth boundary restricts buildable land, thus raising prices and eroding affordability. Our office’s view is that policy matters. When comparing, say, Portland home prices to other large metros, we stand out as being more expensive than most, particularly compared with those of similar incomes. Some of this is likely the long-run effect of our policies. This, of course, leaves to the side any discussion of the reasons why such policies are there in the first place.
That said, our land use laws are not the likely driver behind the low supply and eroding affordability in the past 5 years. The vacancy rate in the Boise MSA is right there with Portland’s and among the lowest in the nation. I have never heard anyone talk about Idaho’s land use laws. Given the underbuilding of housing is not an Oregon-specific issue, using Oregon-specific explanations does not get you very far. UPDATE: Just to clarify. I do think land use laws impact overall prices here in Oregon. I just do not think they are a primary contributor to what has taken place in the past 5 years. Again, the fundamental housing problem is not Oregon-specific.
Supply Constraint #4: Lots
The lack of shovel-ready, or buildable lots is clearly a constraint on the housing market today. Builders nationwide are reporting shortages at an increasing rate. The issue is worse in the West, and in prime locations — so-called A lots — but is still a major and growing concern throughout. Locally, the issue is largely the same, although Oregon’s land use laws can come into play. It is not necessarily the total amount of zoned land — there is supposed to be a 20 year land supply within the UGB. In conversations, what builders really care about is the effective land supply — or the amount you can actually build on in relatively short order. Reasonable people can and do disagree about the assumptions in the former, but clearly the latter is a problem here in Oregon, and across the country.
Overall, the lack of buildable lots results in higher prices and fewer units. However, as Dave Crowe, NAHB’s former chief economist, wrote in 2014 and in 2015, the lack of land is due to tight financing. This means that lot supply, while a major constraint, is still more a symptom than a cause of the eroding affordability and meager supply.
Supply Constraint #5: Financing
The housing bubble and Great Recession was a traumatic experience. In its wake, banks tightened their lending standards — both to developers and home buyers. Some of this was clearly needed and welcomed. However, how tight is too tight?
Earlier this decade, banks loosened standards and increased loans for multifamily projects. The result has been a surge in apartments. This increase in supply is now impacting rents. Concerns of overbuilding apartments and with the economy at or near Peak Renter, banks are tightening multifamily standards again.
However, the Fed’s Senior Loan Officer Survey also shows banks tightening standards for construction and land development loans. Given the lack of buildable lots, this is a big concern. Now is not the time to be pulling back on land development. Luckily, this may not be happening across the board. It certainly is happening for multifamily land development, but NAHB has their own survey of their members’ finances. It is an industry publication with a smaller sample size, so the results should be taken with a grain of salt. That said, NAHB members are reporting that banks are still loosening standards in recent years.
At some point, the proof is in the pudding. Loan volumes to builders are growing again, however remain considerably lower than last decade. Below is my replication of a chart current NAHB chief economist Robert Dietz has been using for years. As he notes, these are stocks and not flows. As such we cannot get a perfect look at the increasing flow of credit, but can see it is clearly happening.
Finance and credit availability is a macro lever that can better explain national patterns than any localized issue can. When it comes to housing market confidence, particularly after the bust, it makes some sense that banks and their regulators are more likely to be once bitten, twice shy. In conversation, banks and credit unions are citing some restrictions on their lending activity and issues with making sure their loan portfolios are balanced. I do not know nearly enough about the inner workings of Dodd-Frank to render judgement, but these topics are part of the discussions we have.
Overall credit availability is a good news – bad news story. The bad news is that builder lending volume is considerably smaller today. It takes a lot of time, effort and money to take a piece of dirt, get entitlements, put in roads, utilities, and the like. The dearth of this activity during the bust, for some understandable reasons, has put a wrench in the development process of bringing new supply to the market.
The good news is that the volume of lending has been increasing at double digit rates for the past three years. The flow of credit has returned. Our office’s main housing advisor has been saying that we can expect to have a single family building cycle, that is has just been delayed a long time. He has been two steps ahead at every point in the housing market and appears to be right about this too.
Overall, I am now more of an optimist than in recent years. The apartment surge is beginning to hold down rents and single family construction continues to increase. We are at or near the housing inflection point. Due to stronger household income gains, affordability has largely stopped getting worse. A larger share of households can afford these higher rents and home prices in an improving economy. Between now and the next recession, affordability is likely to get somewhat better. Even so, as our work on the Housing Trilemma shows, regions face trade-offs between affordability, economic strength and quality of life. That said, stronger supply does help with broad regional affordability. The key is continuing to build enough housing to keep up with demand.